The new Greek yield curve

The Greek PSI (new) bonds are now actively quoted. Prices vary with maturities - roughly between €17 and €25 (17 to 25 cents on the euro). Here are the latest mid quotes by maturity.

Latest quotes on Greek PSI bonds

Using Bloomberg these can be converted to yield, producing the following yield curve. This is a unique sovereign curve even for a distressed name because it starts in 2024, with nothing actively quoted prior to that.

The new (post-PSI) Greek yield curve (Y-axis = yield in %)

It is naturally an inverted curve that is pricing in a significant probability of a second default. Depending on the recovery assumptions, the probability of default priced into these bonds in the next 10 years is near certain (the higher the recovery assumption, the higher the implied default probability). Being subordinated to the EU/IMF rescue loans, these bonds don't stand to recover much the next time around.

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The Ukrainians learning from Greece about "debt restructuring"

The Greek PSI restructuring is giving some indebted nations an idea. Debt restructuring is very doable. Debt holders? That's OK, they will be back. Plus who needs them anyway when you have the IMF, which is easier to push around. One nation that is thinking about taking this route is Ukraine.

Bloomberg: Ukraine invoked Greece’s record debt restructuring in a bid to stave off repaying $3 billion to the International Monetary Fund as Standard and Poor’s warned of funding risks and cut the country’s rating outlook to negative.

First Deputy Economy Minister Vadym Kopylov cited last week’s “huge” deal between Greece and holders of its bonds, saying Ukraine may seek a 10-year delay in repaying the IMF under a $16.4 billion rescue program granted in 2008. The lender said it hasn’t been asked to reschedule payments.

Recently the Ukrainian government decided to increase spending on social programs by at least 1.2% of GDP above what was targeted in the budget as part of the original IMF financing. This is how politicians get reelected (not much different than in the US).

A couple of weeks ago Prime Minister Azarov also said that Ukraine should receive new IMF financing - just because... The new funds would be used to pay interest on the 2008 loan. Of course the IMF didn't go for that proposal.

Now the Ukrainians are having a tough time negotiating natural gas purchases from Russia and may end up buying gas elsewhere. They are looking to get sizable discounts because the nation is running out of funds. Given that the Russians control most natural gas supplies in Europe, it's not exactly clear where Ukraine would be buying it from. And as before, the Russians could simply turn the spigot off. If that were to happen, the Ukrainians would have other things to worry about than the $3bn IMF payment they need to make this year.

Ukrainian CDS widened last week to 757bp. This is far above the Markit iTraxx SovX CEEMEA index of sovereign CDS, which comprises of 15 emerging markets names in the Central  and Eastern Europe, Middle East and African countries (a good benchmark for emerging markets CDS). The chart below is the spread between Ukrainian CDS spreads and the SovX CEEMEA index.

Ukrainian CDS - SovX CEEMEA (Bloomberg)

Bloomberg: Negotiations to restructure Ukraine IMF debt “are on,” Kopylov told reporters yesterday in the capital, Kiev. “Why not? If we have Greece and such huge debts.”

Max Alier, who heads the IMF’s office in Ukraine, said yesterday that the fund has no “mechanisms to restructure or reschedule payments” and hasn’t received “any requests” from the government to do so.

No mechanism to restructure IMF debt? That's too bad, because that's exactly what the Ukrainians may be intending to do. After all they've learned from the best in the debt restructuring business.

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Another good paper (and some comments) on TARGET2 imbalances

Attached is another good reference paper on the Eurozone's Target2 imbalances (hat tip Kostas Kalevras, @kkalev). A few comments on the topic:

1. The paper correctly points out the issue of liquidity imbalances (discussed here). This creates a divergence of money stock growth between the core and the periphery and severely impedes ECB's efforts.

2. Awash with liquidity Germany is more likely to decouple from the rest of the Eurozone, while the periphery would be hit by both tight money supply (tight credit conditions) as well as the various austerity related cuts. This will create a tremendous wealth disparity (and related social consequences) within the Eurozone.

3. It is important to clarify that Bundesbank's €500bn of claims is not against other central banks (NCBs), but against the Euro-system - effectively the ECB. If for example Greece were to exit the Union, the losses from the €100bn claim against the Greek Central Bank would be shared by the whole of Eurozone. Germany's cut is some 28% of that.

4. However it is possible that some other Eurozone members may not be able to (or decide not to) cover their portion of the losses, making Germany's exposure materially greater than 28%. This is not just a hypothetical scenario because the probability of Greece exiting the Union continues to be quite high in spite of the PSI debt reduction deal.

Enjoy.

Target2- Monetary Policy Implications


A great overview of TARGET2 issues is also available here.

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The latest on the Greek saga

As predicted, the PSI results have triggered a Credit Event. Greece is officially in default. Again, the reason for the big fuss (with some in the financial media completely confused) about the 85% vs. 95% yesterday is that 85% would have resulted in CACs while 95% would not have. That's because 95% would have given Greece enough of a debt reduction without the need for CAC.

The actual number ended up being 83.7% participation for all Greek bonds, 85.8% for Greek Law bonds and 69% for Foreign Law bonds. Here are the results.

Source: BNP Paribas

This afternoon the equity markets reacted negatively to the ISDA announcement that a Credit Event has indeed been triggered. Market's reaction is a bit surprising, given the trigger was fully expected. Some traders are still scared of the old Greek CDS bogeyman.

So what will happen to the holdouts? The 25bn of bonds under the Greek Law will be "CAC'ed" as the chart above shows. They will be forced to deliver their bonds in exchange for the shiny new Greek bonds. The 9bn holdouts of Foreign Law bonds will be looking for door # 4. Some will get "CAC'ed". Others will be able to form blocking positions (each bond will be treated separately).

In the case of a relatively small amount of Greek government guaranteed railway bonds (about 400 million euros issued by Hellenic Railways) there is a chance that bond holders will get paid more than what they would get via the PSI exchange. Here is a good write-up on why that is.

The other holdouts are taking a big chance, although they still have some time (Greece is extending the deadline for Foreign Law bonds tender until  March 23d.) Trying to take on Greece in a UK or a Swiss court is very risky and likely to backfire. Getting a 53.5% of face value haircut is better than getting 100% haircut - plus massive legal bills and years in court (as some have found out the hard way with Argentina). It's not a good idea for the simple reason that Greece simply doesn't have the money to pay them and is unlikely to do so (as it clearly stated again on Friday).

Greece will have a tough enough time just making the ECB whole. The ECB is holding Greek bonds with relatively short maturities (€4.6bn maturing this month alone) and is expecting to be paid par. With the ECB's seniority, Greece will have no money left (see the IFR article on the topic) to pay the holdouts. As the saying goes, "you can't squeeze blood from a stone". The sad fact remains however that unlike many corporate restructurings which are meant to turn the company around, the situation with Greece is grim even after the debt reduction.

IFR: ...one sovereign restructuring adviser said that the situation remained unattractive for bondholders since Greece would remain in such a tough economic position with a heavy debt burden even after the deal cuts out €100bn of liabilities.

“Normally, people tender into an improving situation because they see the debt burden will be reduced and the economy will recover,” he said. “But with Greece it’s very depressing. People tendering here have no option. And I can’t see a significant upside soon.”

And unlike Argentina who has natural resources and was able to rebuild its economy after the default plus a restructuring (although still has major issues), the future for Greece is quite bleak. The likelihood of another default (this time on the new, post-PSI bonds) and an eventual exit from the Eurozone remains high.

Greek unemployment rate (Bloomberg)

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There is a big difference between 95% and 85%

This could be a major blunder for CNBC. They were relying on Reuters for this story.

"About an hour before the deadline expired, the participation rate was nearing 95 percent and responses were still coming in," a Greek government official told Reuters.

But it seems that story is inaccurate. This Bloomberg story was published at about the same time.

While Greece would prefer a voluntary deal, the government has said it will use so-called collective action clauses to force holders of Greek-law bonds into the swap if the private sector involvement fell short and it got approval from investors to change the bonds’ terms. The Greek government had said it wanted participation above 90 percent and was seeking a minimum level of 75 percent. Greece expected holders to accept the offer and was ready to force them if necessary, Venizelos said in an interview earlier this week.

Reuters also flashed the 85% number on their site but there is no story that CNBC quoted. The difference between these two numbers may impact the decision by the Greek government to enforce CACs.

Update: CNBC made some "adjustments" to their article.

CNBC - new language: The official said the figure referred to the voluntary take-up of the offer, however another official said it assumed the activation of collective action clauses (CAC) that would impose the deal on all creditors holding Greek law bonds.

The 95% isn't the voluntary exchange percentage number, which is what the Greeks were supposed to report on Thursday evening. Instead it represents the percentage of bonds to be exchanged after CACs are enforced next week.

That is a fine piece of journalism for which CNBC gets the Sober Look Hype Award. Congratulations.

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There is no door # 4 for the Foreign Law Greek bond holders

Here is some friendly investment advice for those holding a portion of the €18 bn of the “Foreign Law” Greek bonds. You have 3 "doors" to exit your position.

Door #1: If you can still sell your bonds at a premium to the “Greek Law” bonds, that's your best option, but you should sell soon. That premium will be going away shortly and you will have no choice but to participate in the PSI exchange or deliver your bonds to the CDS auction.

Door # 2: If you don’t sell your bonds now, you may have to exchange them in the PSI. In which case your premium to the Greek Law bonds is gone.

Door # 3: When Greece enforces the Collective Action Clause, which they have recently installed into their bonds, the CDS Event of Default will be triggered (subject to ISDA Determinations Committee decision). Your last exit will be to deliver these bonds into the CDS auction.

Many Foreign Law Greek bond investors are holding out for Door #4, in hopes of creating a “blocking position” that would block the CACs already built into these bonds. The thinking is that it would pressure Greece into some sort of negotiations and incremental value would be extracted. But if you are one of those investors, here is some bad news for you. If you haven’t yet exited via the 3 “doors” (above) and still holding the Foreign Law Greek bonds (after the PSI exchange and the CDS auction), there will not be a door #4. Greece will simply not pay you the coupon or the principal (unless of course you are the ECB.) Remember that by deploying the coercive exchange (CAC) on the Greek Law bonds, Greece will have officially defaulted. There is no reason for them to pay you anything, because the rating agencies will already have Greece declared in default and the CDS will have already triggered. A second default that will occur when you don't get your coupon payment will have no incremental consequences for Greece. Thus a blocking position in the Foreign Law Greek bonds is of no value, since these investors have no negotiating leverage. There is nothing they can do to Greece that hasn't already been done.

Some analysts have thought that by defaulting on Foreign Law Greek bonds after the new (“post-PSI”) bonds have been issued, Greece will trigger a cross-default, effectively defaulting on these new bonds as well. But Greece promptly took the cross-default (proposed) provision out of the new bonds. As far as the Greek government is concerned, they will only have the one new set of bonds. And if you held out on the Foreign Law bonds (and did not take doors 1-3), that’s too bad - you'll just end up getting a doughnut.

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The market is already quoting CDS on the new Greek bonds

The Greek credit event is now fully priced in. The 5yr CDS is trading at 75/78 points upfront with the cheapest to deliver bonds trading in the low 20s. The points upfront pricing for the one-year CDS is almost the same as that for the 5-year contract - typical pricing for a defaulted credit (CDS of all maturities will settle the same way). The CACs will be enforced this Thursday and the ISDA committee will rule this to be a credit event.

The Telegraph: Authorities in Athens are ready to enforce the controversial collective action clauses, or CACs, to impose the restructuring deal on all bondholders as the number of voluntary agreements look set to fall short of the required amount.

What's next? Well, some technical issues around the auction are yet to be worked out. There is also the issue of funding Greek banks which will no longer qualify for standard ECB funding.

The Telegraph: "Greek banks will probably be barred from normal ECB funding and have to turn to the Emergency Liquidity Assistance [provided by the ECB] instead but for how long, we don’t know.”

And then... the sun will rise and the world will go on as usual. The dealers are already quoting CDS on the new PSI exchange Greek bonds. These are quoted at around 20 points upfront and the bets are on for the next Greek credit event. But the markets are starting to shift focus away from Greece and onto Portugal, with volumes for Portuguese sovereign CDS picking up and spreads continuing to stay wide.

Portugal 5yr CDS spread assuming 40% recovery

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Greek PSI exchange summary - an offer you can't refuse

Here is a brief summary of the PSI exchange offer. It's a great deal - why would anyone become a holdout?

For every €100 notional value of the old Greek Government Bonds investors will get:

• €31.5 euros of new Greek Bonds containing Collective Action Clause under the British law with special features like the Co-Financing Agreement. Note that this doesn't mean 31.5 cents on the euro because the new bonds are nowhere close to being worth par.

• The new bonds will be in 20 different maturity tranches ranging from 2023 to 2042. Coupons will step up over time: 2% through 2015, 3% for 2016-2020, 3.65% in 2021, and 4.3% after that. This creates a principal amortization structure similar to a US 30-year mortgage (except the amortization starts in 10 years rather than immediately).

Source: BNP Paribas

• €31.5 of GDP-linked notes (capped payoff of 1%, start paying from 2015 onwards)

• €7.5 mm 1y EFSF notes (PSI Payment Notes) 
• €7.5 mm 2y EFSF notes (PSI Payment Notes)

• Accrued interest on the old Greek Bonds paid with EFSF 6m T-bills.

This results in the face value haircut of 53.5% and an NPV haircut of over 74% (less than 26 cents on the euro) ignoring the GDP-linked notes. The NPV of the GDP-linked notes is €1-2 assuming they pay maximum amount. And for those who believe these will pay the maximum amount because the Greek GDP will recover, I have a bridge in Manhattan I’d like to show you.

Of course don't call this a Credit Event yet, because it is a totally "voluntary" exchange. There is no default - just some bonds changing hands at 26 cents on the euro.

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